As you’ve probably seen on Bloomberg or elsewhere by now, billionaire investor John Paulson is reportedly considering a move from New York to Puerto Rico in order to save on taxes. As Business Insider helpfully summarises, unlike U.S. persons abroad not only will he be able to avoid U.S. federal taxes entirely, but Puerto Rico will not charge him any local income tax on his investment gains either — making Puerto Rico the only place in the Solar System where a U.S. citizen can move and owe no tax whatsoever.
Puerto Ricans deflect the criticism of their plucky little island’s unique tax status by claiming that they have to pay U.S. federal taxes on income from the mainland. But, as Business Insider fails to make clear, “income from the mainland” is determined under the rules of 26 CFR 1.937-2(f) — which means that a U.S. citizen who has lived in Puerto Rico for 10 years and sells the stock of a mainland corporation is deemed to have “income from sources within a possession” and not from within the mainland United States — and thus thanks to 26 USC § 933, owes no U.S. federal capital gains tax. (See IRS Publication 1321 if you’d like an official non-legalese summary of the regulations.) This is a far better deal than the so-called “foreign earned income loophole” that Americans abroad get, which only allows exclusion of wage income — not investments, pensions, local unemployment benefits, nor childrens’ disability benefits.
The other common excuse given by Puerto Ricans for their enormous tax breaks is that they get far less benefit from U.S. federal spending than any of the fifty states — for example, with regards to Medicaid or educational funding. Of course, Americans abroad pay both U.S. and foreign taxes on all our income with more complicated forms than any Homelander or Puerto Rican has ever seen, and we get squat from Medicaid or Medicare or U.S. educational funding — instead we get those “great embassy services” and a vague promise that the U.S. Navy will come save us when we get into trouble. Apparently Puerto Rico has no puertos at which the Navy can dock in the event of a disaster, unlike landlocked Paraguay.
If I was a US citizen, I’d be pissed as hell that expats are treated much worse than Puerto Ricans. Yet, instead, I wish I had money to buy real estate there since it will increase in value as wealthy Americans continue to move south.
It is pretty clear: Under the current legislation If you are a bona-fide resident of Puerto Rico, capital gains on US stock is considered PR source income and therefore subject to taxation by Puerto Rico, but not subject to US Federal Income tax. Under the recent Puerto Rico legislation which excludes capital gains from Puerto Rico taxation for those who transfer their permanent residence to Puerto Rico, there is a real tax incentive to move to Puerto Rico. All US citizens are equal, but some are more equal than others.
I have lived in Puerto Rico. That’s where I met and married my wife in 1956 who taught math at the the English language Robinson School, right next door to St. John’s scool referred to in the Paulson article. Spanish is the lingua franca language there, but English is the common second language today also spoken by a majority of the residents.
Crime is a problem today in Puerto Rico so you should bear that in mind.
Here’s an example from this IRS publication:
These rules apply to dispositions after April 11, 2005. For details, see Regulations section 1.937-2(f)(1) and Examples 1 and 2 of section 1.937-2(k).
In 2006, Cheryl Jones, a U.S. citizen, lived in the United States and paid $1,000 for 100 shares of stock in the Rose Corporation, a U.S. corporation listed on the New York Stock Exchange. On March 1, 2009, she moved to Puerto Rico and changed her tax home to Puerto Rico on the same date. Cheryl satisfied the presence test in 2009 and, under the year-of-move exception, she was considered a bona fide resident of Puerto Rico for the rest of 2009. On March 1, 2009, the closing value of Cheryl’s stock in the Rose Corporation was $2,000. On January 5, 2012, while still a bona fide resident of Puerto Rico, Cheryl sold all her Rose Corporation stock for $7,000. Under the earlier rules, none of Cheryl’s $6,000 gain will be treated as income from sources within Puerto Rico.
Had Cheryl moved to Puerto Rico earlier, the capital gain would have been treated as income from sources outside of Puerto Rico and subject to US income tax..
Watch as property values in Puerto Rico go through the roof as the news gets around on this tax incentive to relocate there. nd by the way, the US Navy has a substantial presence in Puerto Rico, as does the US Army at Ft. Buchanan. That is where I was inducted into the army for 2 years of obligatory military service and discharged 2 years later.
A new Bloomberg article called: “Puerto Rico Beyond IRS Reach Woos Paulson-Sized Fortunes”.
An excerpt that was informative: “Puerto Rico’s separate tax system makes it different from several other U.S. territories. Guam, the U.S. Virgin Islands and the Northern Mariana Islands all use what is called a “mirror code,” in which they use the U.S. tax code and substitute the name of the territory each time the law says United States. The District of Columbia is treated generally like a state for tax purposes.”
@Roger, Example 1 indicates that the person would still be subject to US tax on the entire capital gain. The interesting part is Example 2 from the same link, which explains that a person can allocate the gains between the US and the territory:
Assume the same facts as in Example 1, except that Cheryl makes the special election to allocate the gain between her U.S. and possession holding periods. Cheryl’s possession holding period began March 1, 2009, the date her tax home changed to Puerto Rico. Therefore, the portion of gain attributable to her possession holding period is $5,000 ($7,000 sale price – $2,000 closing value on first day of the possession holding period). By reporting $5,000 of her $6,000 gain as Puerto Rico source income on her 2012 Puerto Rico tax return (and the remainder as non-Puerto Rico source income), Cheryl elects to treat that amount as Puerto Rico source income.
It’s better to treat the gain as Puerto Rico income because the Puerto Rican capital gains tax rate is 10% (or zero under the new resident program), much less than the current 20% in the US.
US citizens and permanent residents who live in Puerto Rico or American Samoa, and only have income from the territory, only have to file a tax return to the territory’s tax agency, not to the IRS. If they have income from outside the territory (for example, from the US or from any other country), they have to file a tax return to the IRS too. The income from outside the territory is taxed by both the territory and the US, but the US allows a credit for the tax already paid to the territory on the same income. However, as the example above explains, capital gains not on real estate earned as a resident of the territory are considered to have a source in the territory, even if the actual source is elsewhere. Another exception is that income from employment in the US government is treated as US source, even if the work location is actually in the territory.
US citizens and permanent residents who live in Guam, the US Virgin Islands and the Northern Mariana Islands only have to file a tax return to the territory, not to the IRS, even if they have income from outside the territory. This is because these territories apply practically the same tax code as the US.
Also, for purposes of the FBAR, US territories are considered part of the US, so bank accounts there don’t have to be reported on the FBAR (regardless of where the person resides).
Correction: The maximum capital gains tax rate in Puerto Rico is 10%, and in the US it is 23.8%. The actual rate may be lower depending on the person’s income.
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